2. Suppose that a farmer usually makes profit of $120,000 per year. Let's say that there is a 2% chance that a tornado will hit the farm. This would strongly hurt farmer's profit, leading to losses of $96,000 with 2% probability. a. What is the actuarially fair insurance? b. Assume that the farmer utility is given by u = T 0.5 where t represents profit. What is the farmer's expected utility with no insurance? c. How much would the farmer be willing to pay to have insurance? d. Assume that the farmer expects that the tornado's effect to your farm is lower, only leading to losses of $70,000. i. What is the actuarially fair insurance? ii. What is the farmer's expected utility with no insurance? iii. How much would the farmer be willing to pay to have insurance? iv. What is the risk premium?

2. Suppose that a farmer usually makes profit of $120,000 per year. Let's say that there is a 2% chance that a tornado will hit the farm. This would strongly hurt farmer's profit, leading to losses of $96,000 with 2% probability. a. What is the actuarially fair insurance? b. Assume that the farmer utility is given by u = T 0.5 where t represents profit. What is the farmer's expected utility with no insurance? c. How much would the farmer be willing to pay to have insurance? d. Assume that the farmer expects that the tornado's effect to your farm is lower, only leading to losses of $70,000. i. What is the actuarially fair insurance? ii. What is the farmer's expected utility with no insurance? iii. How much would the farmer be willing to pay to have insurance? iv. What is the risk premium?

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.5P

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